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The Nonlinear Effects of Fiscal Policy

Author

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  • Pedro Brinca
  • Miguel Faria-e-Castro
  • Miguel H. Ferreira
  • Hans Holter

Abstract

We argue that the fiscal multiplier of government purchases is nonlinear in the spending shock, in contrast to what is assumed in most of the literature. In particular, the multiplier of a fiscal consolidation is decreasing in the size of the consolidation. We empirically document this fact using aggregate fiscal consolidation data across 15 OECD countries. We show that a neoclassical life-cycle, incomplete markets model calibrated to match key features of the U.S. economy can explain this empirical finding. The mechanism hinges on the relationship between fiscal shocks, their form of financing, and the response of labor supply across the wealth distribution. The model predicts that the aggregate labor supply elasticity is increasing in the fiscal shock, and this holds regardless of whether shocks are deficit- or balanced-budget financed. We find evidence of our mechanism in microdata for the US.

Suggested Citation

  • Pedro Brinca & Miguel Faria-e-Castro & Miguel H. Ferreira & Hans Holter, 2019. "The Nonlinear Effects of Fiscal Policy," Working Papers 2019-015, Federal Reserve Bank of St. Louis, revised 22 May 2020.
  • Handle: RePEc:fip:fedlwp:2019-015
    DOI: 10.20955/wp.2019.015
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    References listed on IDEAS

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    Cited by:

    1. Brinca, Pedro & Duarte, João B. & Holter, Hans A. & Oliveira, João G., 2019. "Investment-Specific Technological Change, Taxation and Inequality in the U.S," MPRA Paper 91960, University Library of Munich, Germany.
    2. Nadav Ben Zeev, 2019. "Identification of Sign-Dependency of Impulse Responses," Working Papers 1907, Ben-Gurion University of the Negev, Department of Economics.
    3. Bernardino, Tiago, 2019. "Asset Liquidity and Fiscal Consolidation Programs," MPRA Paper 93903, University Library of Munich, Germany.
    4. Freitas, Bruno, 2020. "Labour Share Heterogeneity and Fiscal Consolidation Programs," MPRA Paper 98973, University Library of Munich, Germany.
    5. Ferrreira, Ana Melissa, 2019. "Skill-Biased Technological Change and Inequality in the U.S," MPRA Paper 93914, University Library of Munich, Germany.

    More about this item

    Keywords

    Nonlinearity; Fiscal Multipliers; Heterogeneous Agents; Asymmetry;

    JEL classification:

    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy
    • E21 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Consumption; Saving; Wealth

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